Leave the Era of ‘Perceived Reality’ Behind

The political and economic turmoil of the past month shows that the collision of these two forces can be awkward (McCain’s “suspension” of his campaign to help Congress approve a bailout; Obama’s run-in with Joe the Plumber) and painful (the equity markets’ swoon when Congress continued to wrangle over the bailout).

The overlap of politics and economics can also be ugly: consider how one of the key tenets of political success in the past 30 years also spilled into business – and the financial services sector, in particular.

That tenet, notes Wall Street Journal columnist Thomas Frank, is “perceived reality.” Frank cites a new book about political strategy that explores the impact of a principle a Ronald Reagan’s pollster hatched in 1980: “People act on the basis of their perceptions of reality; there is, in fact, no political reality beyond what is perceived by the voters.”

Frank explains that this observation enabled political conservatives in the U.S. to triumph over political opponents during the past three decades. (His column goes on to argue that Joe the Plumber’s perception of reality is at odds with his actual experience and will likely make his future reality more economically painful.)

A financial form of “perceived reality” also took root in the balance sheets of banks, the culture of financial architects, the minds of home-buyers, and the decisions of regulators.

When it comes to each of these areas, it turns out that reality matters more than perception. Lenders want to know the true nature of risk. Financial wizards need to know the DNA of the complicated assets they’re buying and selling (ask Lehman Brothers what happened when the music stopped). Home buyers and home owners need to learn and accept the true cost of credit. And regulators need to understand the true impact of delaying action (and also the difference between quantity and quality when it comes to rules-making).

The era of perceived reality needs to come to an end, and it ought to be ushered out by a new era of transparency.